Similar, Yet Different Too

Does the private equity ownership type give AM Best pause for concern?

Let me say that it is not the form of the company but the activity that goes on in it that we look at. The partners in a private equity firm expect a certain return on their investments at a particular time, but so do stockholders in a publicly traded company. For the most part, they have the same goal. The organizational structure may not matter quite as much as what is going on in the company.

There is some history to suggest that what is going on in a PE firm, investment-wise, should be concerning. Some PE firms reportedly are using life insurance assets to invest in alternative investments, including their own real estate, buyout and debt funds, at high fees. According to a recent report by McKinsey, through Sept. 30, 2022, PE performed worse than other private asset classes for the first time since 2008. We do see companies owned by PE firms that go belly up, which are then held up as an example [of an unfavorable track record], which may be blown out of proportion. The fact that more life insurance assets are held by PE is a concern on its face, but as I said, it comes down to the activity and the insurance expertise in the company.

Assuming expertise in insurance activities, a private equity firm will be more inclined not to jeopardize policyholder interests?

Asset managers that have insurance DNA in them, such as underwriting and claims expertise, may have a better track record than firms that don’t have this expertise. You can see all the returns in the world, but if you severely underprice the products, that may produce bigger issues in the long run. Insurance expertise is a pretty big deal for our analytical teams assessing the quality of management. PE firms with a track record of insurance are viewed more favorably than those jumping in without it.

A concern raised by consumer advocates is that some PE firms may leverage their returns from non-insurance assets to charge lower premiums than competitors. Many mutual insurers owned by their policyholders, for example, tend to be more conservative in their investments. In turn, this may create an uneven playing field. Your thoughts?

I can see that as a legitimate concern. If a PE firm gets higher returns on their investments, they have some wiggle room to potentially undercut competitors in pricing. You’re right that the mutuals tend to be more conservative in their pricing. Many smaller mutuals are more focused on the life side as opposed to annuities. There’s less interest rate fluctuation in that sort of risk so more of a level playing field. But for the larger mutuals involved in annuities, lower premiums charged by competitors may result in less money coming in the door to pay future obligations. We’ve heard these concerns. Again, it goes back to the company’s insurance DNA and expertise and whether the more competitive pricing will become an issue down the road.

Another concern regarding private equity firms is how long they hold on to a company before selling it again, generally three to seven years on average. Is this in store for the PE-owned life insurers?

My sense is the mentality is different with regard to owned life insurance assets, given the steady revenue stream from policyholder premiums. PE sees this as a constant flow of money. Put to work, they believe they can gain better investment yields than standard insurers, given their in-house expertise in alternative assets like CLOs [collateralized loan obligations] and private placements. Some PE firms are thinking long term; they’re in it for the long haul.

It’s not a stretch to see why private equity is interested in life insurance, given the huge pool of cash from insurance premiums and annuity payments. But what if they do decide to get out in three to seven years? Is it as easy to get out of the business as it is to get into it?

Well, it’s easy to get into the life insurance industry if you have a whole lot of capital, but the tough part is exiting. Once you have this book of insurance business and liabilities anywhere from five to 30 years depending on the products you sell, it can be difficult to find a potential buyer, particularly if you mispriced products or experienced underlying issues within the business. … Management needs to have an end game before they enter the industry, because it will be difficult to get out once you’re already in.